Finance Committee on May 15th, 2007

[The Chair, Conservative, Brian Pallister]

Good morning, committee members.

Good morning to our witnesses. Thank you for being here.

Thank you to all for submitting the information that you have already submitted. You know that this morning will be limited somewhat in terms of the time available for presentations. I think we notified each of you that you'll have five minutes for introductory remarks.

Welcome again, and thank you very much for being here.

Pursuant to Standing Order 108(2), we'll continue with our briefing on tax havens and tax avoidance. We'll begin with Ben Arrindell from the Barbados Private Sector Association.

Mr. Arrindell, welcome and thank you. You've come a long way, and we appreciate your being here.

[Ben Arrindell, Barbados Private Sector Association]

Good Morning.

My name is Ben Arrindell. I am the chairman of the Barbados Private Sector Association, and I am also the Barbados representative on the United Nations committee of experts on international cooperation in tax matters.

I thank you for the opportunity to address you this morning. The purpose of my address is to attempt to provide some balance to the current debate on the issue of the abusive use of tax havens, and to correct the portrayal of Barbados as a tax haven.

There is no universal definition of a tax haven. Many people, countries, and international organizations have attempted to provide their own definitions. In the debates over the past two weeks, which I have followed, I have seen some suggestions to the effect that any country with a tax rate lower than Canada's is a tax haven. In my view, that is an extremely simplistic view of the matter, and I would suggest that this kind of interpretation is fraught with difficulties.

The OECD, in its initiative on harmful tax competition, back in 1999-2000, focused on four issues in attempting to define a tax haven: a lack of transparency in tax laws and regulation, a lack of exchange of information, a country that levies no taxes or nominal taxes, and a country that encourages businesses that lack substance. With that definition in mind, let me seek to talk specifically about Barbados.

The Barbados strategy for the development of international business and financial services is based on transparency, free and active exchange of information within the framework of a tax treaty, and a lack of bank secrecy and legal impediments in its domestic laws to the exchange of information. Based on its commitment to these factors, and taking into account Barbados' compliance with these factors, the OECD removed Barbados from the list of tax havens, without Barbados having to sign any commitments to the OECD.

Since the OECD initiative, and since Barbados was removed from that list, there has been a grey network of double taxation agreements that have been signed and concluded by Barbados with OECD member countries. I think this is an indication that such countries do not regard Barbados as a tax haven. The Netherlands and Austria are just two examples of countries that have signed full double-taxation agreements with Barbados.

The OECD talked about low taxes. I've seen a number of references to this in this debate. I should mention that this only applies to certain entities involved in certain activities. These are the activities that Barbados has targeted for future economic growth--for example, the international business and financial services. But we also have incentives to encourage tourism, manufacturing, and so on.

The provisional incentives to investors are not unusual, as many countries, both developed and developing, offer such incentives—and this includes Canada. In that respect, Barbados is no different from other countries. I should mention that Barbadians can also own the entities that are specially tax-privileged.

I turn now to the Canada-Barbados treaty relationship. There has been mention of the fact that apparently Barbados has changed its legislation since the treaty was introduced. That is not the case. The treaty was signed in 1980, and at that time Barbados had international business companies that were able to benefit from a low tax regime. A testament to this is the fact that IBCs are excluded from being able to benefit from the Canada-Barbados treaty, so they did exist at that time.

Finally, I'll just talk very quickly about the contribution to Barbados of the international business and financial services sector, in terms of its contribution to foreign currency earnings, government revenues, jobs, tourism, development of specialized skills and transfer of those skills to Barbadians, and development of technology.

[The Chair, Conservative, Brian Pallister]

Thank you very much, Mr. Arrindell.

We'll continue with the Canadian Labour Congress representative, Erin Weir. Welcome. It's over to you, Erin.

[Erin Weir, Economist, Canadian Labour Congress]

Thanks very much for having me before this committee.

Broadly speaking, I think there are two ways in which Canada can address the issue of tax havens. The first is to continue to reduce Canadian corporate taxes to in effect make Canada itself a tax haven. That seems to have been the thrust of Canadian tax policy over the past decade.

The other option, and the one I'm going to be supporting, is that Canada can structure its tax system in a way that collects appropriate corporate tax revenue despite the existence of tax havens offshore.

In particular, I'd like to focus on the issue of interest deductibility, which has become entangled in this debate about tax havens. Yesterday the Government of Canada announced that it would continue to allow corporations, for the most part, to deduct from their Canadian taxes interest on loans to finance their foreign affiliates.

The proposal I would like to put to this committee is that if the government is going to implement that plan, it should also begin taxing the income of foreign affiliates of Canadian corporations.

The basic principle of corporate tax is that it should apply to profit, which is income minus the expenses incurred in generating it.

Prior to the last federal budget, corporate Canada was having its cake and eating it too. It wasn't paying any tax, or was paying almost no tax, on the income of its foreign affiliates, but at the same time it was able to deduct the financing costs of those affiliates from its Canadian taxes.

What budget 2007 proposed to do was to put Canada's corporate tax system on a purely territorial basis, so that Canada would tax income generated in this country and allow the deduction of expenses incurred in generating that income.

The criticism of that budget measure was essentially that Canada needed foreign affiliate interest deductibility in order to be competitive, because other countries had that type of deduction. What critics neglected to mention, of course, was the fact that other countries that allow that deduction, such as the United States, Britain, and Japan, also tax the incomes of the foreign affiliates of their corporations. In other words, they tax corporations on a worldwide basis, including the incomes of foreign affiliates, and allow the deduction of the expenses of those affiliates.

I'd just like to read into the record a quotation from Bruce Bartlett, in his brief analysis of corporate taxes for the National Center for Policy Analysis in the United States. The quote begins:

The United States’ tax system is “worldwide,” requiring domestic companies to pay taxes on income earned abroad. Thus, for example, a territorial company that incorporates in Canada pays taxes only on its operations in Canada. If it has a U.S. subsidiary, the subsidiary pays U.S. taxes on its profits here, but none to Canada. However, due to the U.S. worldwide tax system, the exact same U.S. company with an identical Canadian subsidiary will pay Canadian taxes plus U.S. taxes on its Canadian operations. The U.S. company will pay more total taxes even if the United States and Canada have the same tax rates.

Of course, Canada will now have lower tax rates than the United States. So it seems that we're headed in the direction of becoming a tax haven ourselves.

To put the Canadian corporate tax system back on a consistent basis, what I would propose we need to do is start taxing Canadian corporations on a worldwide basis. That would put them on exactly the same footing as their American, British, and Japanese competitors, where they would be able to deduct the interest costs of setting up these foreign affiliates and then would have to pay Canadian taxes on the incomes of those foreign affiliates.

A final benefit of this plan is that it would guard against tax havens, because Canadian-based companies would be taxed at the Canadian rate on all of their activities in the world. For example, if a Canadian company were to set up a foreign affiliate in Barbados, it would pay the Barbados corporate tax and then would be able to deduct it from the Canadian tax it would pay on those operations. But overall, it would face exactly the same tax rate on its operations in Barbados as on its operations in Canada.

In addition to the fact that I think this just makes rational sense from a theoretical perspective and would put the Canadian tax system on a consistent basis, I also think it would go a great distance towards guarding against tax havens.

Thanks very much.

[The Chair, Conservative, Brian Pallister]

Thank you very much, Mr. Weir.

We'll continue now with Brigitte Alepin, chartered accountant and fiscalist.

Welcome. You have five minutes, Madam.

[Brigitte Alepin, Chartered Accountant, Fiscalist, As an Individual]

Thank you.

You ask me how we can solve the problem of tax havens, and this is an enormous issue. I've spent several years trying to answer that very same question. I should like first to clarify one point:: when we are asked to solve a problem, we are not asked to solve the consequences of that problem. In dealing with the problem of tax havens, the Canadian government often makes the mistake of focusing solely on the consequences of tax havens. By dealing with a tax agreement of which Canada is signatory, or any of the tax laws you are referring to, we always deal with the consequences of the problem. Therefore, even if we were to find the perfect answer, the problem of tax havens would continue to exist. Since you are asking me to make suggestions on how to solve the problem, I assume that you are prepared to think in broad terms and that you want to solve the problem, rather than its consequences.

In attempting to find solutions to the problem of tax havens, I try to picture the situation. It is akin to a spectator who stands up alone in the middle of a seated crowd. And then, on his own he decides to watch the show standing up. Similarly, tax havens like this standing spectator, take advantage of the situation. In fact, other countries, including Canada remain seated. If we were to decide to imitate the spectator and all of us watch the show standing up, the spectator like the tax havens would lose their marginal advantage. They would therefore lose all of their benefits.

Regardless of how we complicate the situation, we always come back to two distinct possibilities: we can either ask tax havens to take a seat, or ask countries, such as Canada, for instance to be the victims of the situation, and accordingly ask taxpayers to allow this injustice to continue. In talking about tax havens, it is mostly a matter of intuition. In Canada, tax history dates back only 60 years. In terms of the global tax experience, tax havens are a relatively new problem. My impression is that if we were to ask other countries and Canadian taxpayers to keep on supporting the tax unfairness and injustice cause by tax havens, we might challenge them.

If some of you are skeptical and believe that the taxpayer is a passive being, incapable of rebelling, but capable of enduring this kind of injustice for long, I will remind you that America resulted from the Boston Tea Party. If I may say so, there are plenty of taxpayers who are simply fed up.

If we want to solve the problem of tax havens, there is only one choice: that is to ask those countries to follow the same rules as other countries, and sit down. One things is certain: we will not reach that goal overnight. We must deal with this issue internationally. In the context of globalization, there are organizations that deal with a vast array of issues, including health, labour standards, and so on. However, since the advent of globalization, there is not a single world organization that is dedicated exclusively to tax matters. The OECD is not what I am alluding to now.

To my mind, this is the only way to establish a consultation table that would bring together all countries that are being treated unjustly because of tax havens. Together, we can talk about real issues loud and clear in an effort to convince the representatives of tax havens to sit with us so we can view together the show that is unfolding on the international stage.

Thank you.

[The Chair, Conservative, Brian Pallister]

Merci, Madame.

We continue now with Professor André Lareau, from Laval University.

Welcome to the committee, sir.

[André Lareau, Professor, Laval University]

Thank you and good morning.

Canada has made a choice in its legislation. My comments will focus more on these legislative choices so that we can find solutions to solve the problems associated with tax havens.

In order to tax a Canadian company, the notion of residence must be taken into account. Residence must be initially established in order to levy taxes in Canada. A company located in Canada pays taxes on its global income. Of course, companies which have decided to lessen their tax burden have opted to put aside the notion of residence and go somewhere else. A foreign entity, in the form of a company, is then created in a tax haven such as Barbados, even though Barbados does not constitute a tax haven according to several economists, because tax rates are extremely low for IBCs, International Business Companies, and hover between 1% and 2.5%.

This is where the problem arises: under the current notion of residence as we know it, a company, even though established in Barbados, can be considered as residing in Canada if the control centre of that company is located in Canada. During a trip to Barbados in 2004, I quickly realized that for the sum of a few dollars, many professionals working in Barbados offer their services to incorporate a company. As such, one can easily find columns of professional plaques displayed in many of the law firms operating in Barbados. One simply needs to go to the Registrar's Office or to the Corporate Office to find a list of many companies that ultimately reside in Canada. A quick visit will reveal that there are many companies in Barbados, but that pay their dividends to Canadian residents.

Of course, Barbados has a tax agreement with Canada, as was mentioned earlier, and that even excludes IBCs. Yet, Canadian regulation, no. 5907(11.2)(c) specifically excludes entities created in Barbados, subjects them to Canadian tax and allows such entities to pay dividends to the Canadian parent company tax-free, something that is the exclusivity of companies that are subject to the agreement. However, the famous 5907(11.2)(c) regulation brings Barbados back into the fold, with regard to the pay out of tax-free dividends. This is an aberration.

Therefore, the first thing that must be done is to change the notion of corporate residence, doing somewhat what the Australians have done, a new notion of residence dealing specifically with directly or indirect shareholders with voting rights.

There is a second problem that also arises. When a company in Barbados pays dividends to the Canadian parent company, the dividends are not taxed. The Canadian company will then pay out the dividends to its shareholders, and perhaps individuals. The Canadian tax law includes the concept of integration which allows for a Canadian shareholder to receive a tax credit on dividends received, in order to compensate for the taxes paid by the company, thereby avoiding double taxation.

For example, suppose I were a shareholder of Bell Canada stocks or any other tax paying company. I receive my dividends, but I also receive a tax credit to compensate for tax paid by the company. This is an illustration of the concept of integration. Yet, if the dividend is received by a Canadian company that prior to this received funds from the Barbados subsidiary, no taxes are paid. Despite all this, a Canadian shareholder or individual is given a tax credit to compensate for a tax that was not even paid in the first place. Once again, this situation cannot tolerated.

Lastly, there is the notion of disclosure. We cannot control what we cannot see. In 2005, the United States introduced Circular 230, an obligation to disclose aggressive tax schemes.

I therefore include in these aggressive tax schemes the planning to integrate tax havens, and thus the requirement, in all tax planning, to inform tax authorities. England passed a similar measure in 2004 called the tax avoidance scheme.

Thank you.

[The Chair, Conservative, Brian Pallister]

Merci, Monsieur.

We conclude our presentations now with Mr. Walid Hejazi. He's a professor at Rotman School of Business.

Welcome, to you, sir. Five minutes is yours.

[Walid Hejazi, Professor, International School of Business, Rotman School of Business, University of Toronto]

Thank you very much, and thank you for the opportunity to speak to this committee on a topic that's very much related to the research I've been doing for the last decade.

The Government of Barbados has sought to contribute to the academic discourse on international business, especially as it relates to the longstanding relationship between Barbados and Canada. This study is part of that initiative, and the ongoing analysis of that longstanding relationship will involve researchers and academics from the University of the West Indies and the Rotman School of Management and others.

The objective of this study was to look at the effects of that longstanding relationship between Canada and Barbados on the Canadian economy. The results of the study clearly establish that the Canada–Barbados relationship has in fact enhanced the global competitiveness of Canadian multinationals.

Policy changes that adversely affect this relationship would hurt those multinationals, but more importantly, policy changes that adversely affect that relationship would negatively affect the Canadian economy broadly based. There would be reduced Canadian trade, Canadian employment, and Canadian business investment. It is incorrect to assume that changes in that relationship would necessarily result in increased government tax revenue in Canada.

To put this discussion into a broader perspective, let me take you back to 1970. In 1970, for every dollar of investment Canadians had invested abroad, there was $4 invested in Canada. Canada was very much a host economy to foreign investment. Here we are 37 years later, when Canadian multinationals have more investment abroad than there is foreign investment in Canada. The pace at which Canadians have expanded abroad far outpaces the rate at which foreigners are investing in the Canadian economy.

When you dig deep into this data, two results clearly stand out that I think are very important for this committee to consider. First of all, when you look at the data, Canadian multinationals are increasingly locating outside the United States. Increasingly, multinationals are opening markets for Canadian exports in Latin America and East Asia and in Europe. Second, much of these investments is facilitated by conduit jurisdictions like Barbados.

The next point is incredibly important to make, and I'm going to try to say it as clearly as I possibly can. Because Canadian multinationals are going into increasingly unfamiliar environments outside the traditional market, the United States, they're faced with a lot of risk, a lot more risk than they would face when they went to their traditional markets. Therefore, it's very difficult for these Canadian multinationals to compete against companies from the United States and Europe that have longstanding relationships with these markets.

Allowing Canadian multinationals to access these markets through a conduit jurisdiction such as Barbados results in a reduction in the cost of capital for these multinationals that results in the multinationals being more competitive and therefore better able to compete in the global marketplace.

There's a widely held view that simply because a Canadian multinational uses the conduit jurisdiction and there's a tax benefit associated with it, somehow this is bad for Canada. Well, the study I've worked on and the study that was cited to this committee last week by Professor Hines from the University of Michigan clearly show that you need to go beyond that very simple view. The simple fact that there's a tax benefit associated with using these conduit jurisdictions does not mean that the use of these conduits is somehow bad for the Canadian economy.

I want to point out one important distinction between a tax haven and an offshore financial centre. In the handout I circulated to the committee, on page 6 there's a really nice quote from the OECD, which clearly states that Barbados is not a tax haven. There's a fundamental distinction between a tax haven and an offshore financial centre, and it's fundamentally important that, in creating policies that relate to offshore financial centres and tax havens, this distinction be well understood.

The final point I want to make is that when a Canadian multinational accesses an economy in Latin America, the impact on Canadian economic activity is significantly larger than if that Canadian multinational had gone directly to those markets. When a Canadian multinational goes to Latin America through a conduit such as Barbados, that Canadian multinational experiences a reduction in the cost of capital. It's more competitive, and this results in increased production within Canada to service those foreign markets. There will be increased Canadian trade, increased Canadian employment, and so on.

The last two points I want to make are these. The results indicate that changes in the current use of Barbados would hurt the Canadian economy, broadly based; there would be reduced Canadian trade; there would be reduced Canadian production. And furthermore, you cannot assume that tampering with that relationship will result in enhanced tax revenue for the Canadian government.

Thank you.

[The Chair, Conservative, Brian Pallister]

We begin our questions with Mr. McKay. You have seven minutes, Mr. McKay.

[John McKay, Liberal, Scarborough—Guildwood, ON]

Thank you, Chair, and thank you, presenters.

The first point made by Mr. Arrindell and also made by Mr. Hejazi is that Barbados is not a tax haven. I think you've driven home that point. So if anybody, including the minister, refers to Barbados as a tax haven, it would be an error; I assume that's correct.

[Ben Arrindell]

I'm sorry, can you repeat that?

[John McKay, Liberal, Scarborough—Guildwood, ON]

It's simply a very small point, that you made a great effort to distinguish between Barbados and other offshore tax jurisdictions, and you want to say that Barbados is not a tax haven. I thought that was your essential point. Is that correct?

[Ben Arrindell]

Absolutely.

[John McKay, Liberal, Scarborough—Guildwood, ON]

Okay.

So anybody who refers to Barbados as a tax haven is just in error.

[The Chair, Conservative, Brian Pallister]

Mr. McKay, I will not take this off your time, but I would want clarification from both witnesses.

It's my understanding that the OECD quote you referred to and the other reference you made to Barbados not being a tax haven in fact relate to a statement from the OECD that removed Barbados from the list of uncooperative tax havens to the list of cooperative tax havens. Is that correct?

[Ben Arrindell]

You have to make the distinction, because there is no such list of tax havens, as I understand it, within the OECD.

[The Chair, Conservative, Brian Pallister]

So to be clear, removing Barbados from a list of uncooperative tax havens does not make the statement that you've made, that Barbados could not be defined by the OECD as a tax haven.

[Ben Arrindell]

I do not agree with that interpretation.

[The Chair, Conservative, Brian Pallister]

Thank you.

Mr. McKay.

[John McKay, Liberal, Scarborough—Guildwood, ON]

I think precision of language is extremely important here. It becomes a pejorative exercise when it gets referenced as a tax haven, and that somehow or other everybody is getting off with a lucky break, which is frankly nonsense.

I want to get to Mr. Hejazi's testimony, and I appreciate the chair's not interfering with my time. Thank you.

You talked about the risk premium associated with investing outside of Canada, when going into foreign markets. Can you quantify that risk premium and say why it's such a necessary thing when Canadian companies go to invest in Latin America or other non-traditional markets?

[Walid Hejazi]

That's an excellent question. I would like to do a study exactly on that, because obviously the risk premium would vary from industry to industry, but country to country. What we do know is that the risk premium is increasing in markets that are decreasingly familiar to Canadian multinationals. Canadian multinationals, for example, have a long history in Latin America relative to, say, east Asia, so the risk premium within Latin America would be less than it would be in east Asia, for example. Quantifying the risk premium is a difficult question, and one that would be worthy of further study.

[John McKay, Liberal, Scarborough—Guildwood, ON]

You make a statement that is in some respects counterintuitive, which is that these forms of investment are in fact good for the Canadian economy. When Canadians are listening to that, they're thinking: how could that possibly be? All they're doing is getting a tax break and reducing their tax.

And yet even in my own riding, for goodness' sake, I can see that these kinds of investments are good for the Canadian economy. Who does all those back office jobs for these foreign acquisitions but people from Scarborough?

I understand it intuitively, but can you explain it and amplify it further so that Canadians start to understand that what's at risk is actually Canadian jobs?

[Walid Hejazi]

As Canadian multinationals expand abroad, the headquarter activities within Canada increase. That's number one. So we've seen a lot of discussion in the media about this sphere of headquarter activity.

Secondly, the evidence is very clear. This is true within the Canadian, American, and European contexts that when multinationals within any particular country move abroad, it's complementary to domestic trade.

So when the Canadian multinational moves into the U.S. or Latin America, it increases its footprint in that foreign jurisdiction. When it increases its footprint in that foreign jurisdiction, this increases the demand for Canadian production. So jobs within Canada increase to service those markets that are opened by the presence of Canadian multinationals in those foreign jurisdictions. The evidence is very clear on that.

But secondly, much of the income that's generated in those foreign jurisdictions flows back to Canada, and when it is paid out to individuals, to shareholders of these multinational companies, those dividends are taxed.

When the money comes back to a Canadian multinational, it may escape taxation at one level. But when that income is paid out to shareholders—and almost every Canadian has stocks in their RRSPs—the dividend payments that they receive are much higher as a result of these Canadian multinationals being more competitive in the global economy.